Securing Multiple Debts by One Deed of Trust: Maximize Recovery with Dragnet Clauses

A “dragnet clause” is a contract provision stating that a mortgage secures all the debts that the mortgagor may at any time owe to the mortgagee. California courts have upheld the general validity of dragnet provisions. Union Bank v. Wendland, 54 Cal.App.3d 393, 398 (1976). They also recognize the risk that such provisions may be included in a trust deed or mortgage without the debtor’s knowledge or understanding. “Clauses such as this are often termed ‘dragnet’ or ‘anaconda,’ ‘as by their broad and general terms they enwrap the unsuspecting debtor in the folds of indebtedness embraced and secured in the mortgage which he did not contemplate… ‘….” Wong v. Beneficial Savings & Loan Association, 56 Cal.App.3d 286, 292 (1976) emphasis in original.

Most modern forms of deeds of trust contain a dragnet clause. One example follows:

Trustor agrees to (1) pay the principal and interest on the note of even date herewith; (2) perform each agreement in this deed of trust; and (3) pay such further sum as the then recorded owner of the property may hereafter borrow from beneficiary [lender], evidenced by another note (or notes) reciting it is so secured. Bernhard, California Mortgage and Deed of Trust Practice (3rd. Ed.), The Regents of the University of California, 2000; page 699.

While Courts will generally uphold the validity of dragnet clauses, that is not always the case. Often when challenged by the debtor or creditors who also claim a security interest in the real property secured by the deed of trust, Courts construe the clause as not including certain debts that the creditor asserts are secured by the deed of trust. This article will state the current state of the law with regard to the validity of dragnet clauses covering pre-existing or contemporaneous debts (either in existence or entered into at the time the deed of trust was executed) or those debts incurred after the deed of trust was recorded.

Pre-existing or contemporaneous debts.

Courts in California have rejected the view that a broadly worded dragnet clause may never be applied to other existing or contemporaneous debt. However, California Courts have consistently adhered to a construction of such clauses that depends more on “the actual expectations of the parties… than the literal wording of the boilerplate clause.” Fischer v. First International Bank, 109 Cal.App.4th 1433, 1435 (2003) citing Ostayan v. Serrano Recoveyance Co., 77 Cal.App.4th, 1411, 1421 (2000). Generally a proponent of a dragnet clause bears the burden of establishing that the parties intended all existing or contemporaneous loans to be included within its scope. Wong, supra, at 294. This construction makes sense because it is easy to include specific existing obligations when that is the party’s intent. If the parties fail to include those obligations a court can likely confer that no such intent existed or that, if it did, it was a secret intent. Fischer, supra, 109 Cal.App.4th at 1447. When you add to that analysis the view in California that a trust deed containing a dragnet clause that is printed on a standard bank form is considered a contract of adhesion, Lomanto v. Bank of America, 22 Cal.App.3d 663, 668 (1972), enforcement will depend on whether the provision is within the reasonable expectation of the weaker or “adhering” party (the Bank’s customer). See Armendariz v. Foundation Health Phychcare Services, Inc., 24 Cal.4th 83, 113 (2000).

Relevant factors articulated in the case law which help

California Courts determine whether a broadly worded dragnet clause was mutually intended by the parties to cover pre-existing or contemporaneous debts include: (1) the language and specificity of the dragnet clause; (2) whether the parties were aware of the dragnet clause and appreciated its significance; (3) whether the other loans were of the same type or character as the primary loan; and (4) whether the Bank relied upon the dragnet clause as security for the other loans. Fischer, supra, 109 Cal.App.4th at 1446.

In order to make it more likely that if challenged by the debtor or another creditor, a dragnet clause would be construed to include contemporaneous or pre-existing debts, creditors should consider these options.

Specify in the deed of trust the specific debts that intend to be covered by the deed of trust. Since it is preferable to utilize forms, it may be appropriate to modify the form to include reference to an exhibit so that all the debts can be listed.

Include in the instruments that are to be secured by the deed of trust specific reference to the fact that a deed of trust of a certain date is to serve as security.

Have the debtor sign a separate document stating the debtor specifically recognizes that more than one debt is to be secured by the deed of trust and that the debtor recognizes the significance of that fact. For example, if the debtor defaults on one of the obligations secured by the deed of trust, the foreclosure process could begin.

The creditor’s internal documents should establish very clearly that the deed of trust is to serve as security for multiple obligations.

The loans to be secured by the deed of trust should be similar in character.

Future advances.

In contrast to debts which may be in existence when a deed of trust is signed and recorded, other issues arise when a lender lends additional monies after the deed of trust is signed and recorded and wants the obligation secured by the deed of trust expanded to include the later advances. Obviously, if a loan is in existence when a deed of trust is signed and recorded, a strong argument could be made that if the parties intended to include those loans under the umbrella of the deed of trust, they could have done so. Such an argument may not be available with respect to future advances made by a lender.

The California Civil Code contemplates that a lien may be created and take immediate effect as security for performance of obligations which do not yet exist. Civil Code Section 2884. The example of the dragnet clause at the beginning of this article limits the obligations secured by a deed of trust to those that specifically refer to the existing deed of trust.

As with contemporaneous or pre-existing obligations, the courts try to construe dragnet clauses consistent with the expectations of the parties. Strong evidence of the party’s intention to include subsequent loans is if the initial and subsequent loans are related. See Union Bank, supra, 54 Cal.App.3d 393. Where disputes arise generally is not between the debtors and creditors in this area but rather between creditors asserting priorities to the collateral. Obviously, if a deed of trust specifically describes future obligations that it secures, a competing creditor will have difficulty establishing that the advance made under that deed of trust is not entitled to priority. This is especially true if the party subsequently signs notes or other instruments specifying the debt was secured by that deed of trust. See Bernhard, supra, at page 708. However, if the creditor has to rely upon a broadly worded dragnet clause, a debtor can argue that it did not know what the clause meant and bring into question the validity of the security for the advance. Lomanto, supra, 22 Cal.App.3d 663.

Many lenders are aware of issues that arise whether an advance made by a lender secured by a deed of trust is optional or obligatory. If obligatory advances, they are generally believed to be secured by the deed of trust. However, if the advances are optional, they are not. Deeds of trust rarely state whether future advances are optional or obligatory. In many cases, deeds of trust do include covenants of the borrower that if the lender has to make certain expenditures (such as attorneys’ fees) to protect the security, it will be secured by the deed of trust. Those types of clauses, however, while technically “future advance clauses” really are more specific statements of the borrower’s obligations which are secured by the deed of trust. Some helpful guidelines for lenders with senior liens that may contemplate additional advances are:

Specifically state in the deed of trust the amount and timing of advances that may be required and for which the deed of trust will act as security.

Any subsequent instrument signed that is to be secured by the deed of trust should make specific reference to the deed of trust.

Provide notice to any subordinate creditor who has recorded a deed of trust or that the senior lender knows about prior to the advance.

At the same time if a lender wishes to loan funds to a debtor secured by property that is already encumbered, that lender should protect itself in a priority dispute with a senior lienholder. Here are some suggestions to do so:

Perform a careful title search to determine the identity of any senior lienholder.

Inquire of any senior lienholder of the amount due. Civil Code § 2943 requires the beneficiary of a deed of trust to provide information to certain persons including the trustor or mortgagor under that deed of trust.

Give notice to the senior encumbrancer of the existence of the junior lien.

Obtain warrantees and representations from the borrower about the balance due secured by the senior trust deed.

Conclusion

Dragnet clauses are enforced by courts to the extent they accurately reflect the parties intentions. They can accurately reflect intentions provided lenders and borrowers carefully document their positions. Both senior lienholders and junior lienholders can take steps to protect themselves in priority fights concerning the collateral by following a few reasonable steps.